I was solving both question banks when I came across these contradicting statements.
Question on Finquiz
I selected the B option
But according to FinQuiz A is correct and B is wrong because -
“Derivatives are priced assuming that the market is free of arbitrage opportunities.The correct derivatives price assures that market is free of arbitrage opportunities”
But for a similar Question on Scheweser Qbank
“The calculation of derivatives values is based on an assumption that:”
A) arbitrage opportunities do not arise in real markets. B)arbitrage opportunities are exploited rapidly. c)investors are risk neutral. On this Schweser states B as the answer,the reasoning being Derivatives valuation is based on the assumption that any arbitrage opportunities in financial markets are exploited rapidly so that assets with identical cash flows are forced toward the same price. It does not assume arbitrage opportunities do not arise or that investors are risk neutral. Am I misunderstanding or do they both contradict each other?Which one is correct?
What I think you might be missing here is that answer B from FinQuiz states that the market has exploitable arbitrage opportunities. This is different from saying the market has exploited arbitrage opportunities, like Schweser does.
Well, first of all, the FinQuiz answer B should read “ensures”, not “assures”.
Second, correct derivative pricing ensures that there are _ no _ arbitrage opportunities; i.e., correct pricing prevents arbitrage.
Schweser’s reference to rapid exploitation of arbitrage opportunities is a roundabout way of saying that those opportunities don’t exist. (Should they arise, they’re gone in a nanosecond.)
